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The Relationship between Exchange Rates and Interest Rate Differentials: A Wavelet Approach
Author(s) -
Scott Hacker R.,
Karlsson Hyunjoo Kim,
Månsson Kristofer
Publication year - 2012
Publication title -
the world economy
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.594
H-Index - 68
eISSN - 1467-9701
pISSN - 0378-5920
DOI - 10.1111/j.1467-9701.2012.01466.x
Subject(s) - economics , exchange rate , international fisher effect , interest rate , interest rate parity , currency , differential (mechanical device) , econometrics , spot contract , covered interest arbitrage , monetary economics , asset (computer security) , wavelet , fisher hypothesis , financial economics , real interest rate , computer science , futures contract , computer security , engineering , artificial intelligence , aerospace engineering
This paper uses wavelet analysis to investigate the relationship between the spot exchange rate and interest rate differential for seven pairs of countries, with a small country, Sweden, included in each case. The key empirical results show that there tends to be a negative relationship between the spot exchange rate (domestic‐currency price of foreign currency) and nominal interest rate differential (approximately the domestic interest rate minus the foreign interest rate) at the shortest timescales, while a positive relationship is more frequently found at the longest timescales. This indicates that among models of exchange rate determination using the asset approach, the sticky‐price models are supported in the short run and flexible‐price models in the long run.